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What is Fibonacci?
To explain it succinctly, Fibonacci is a set of predetermined price levels of an instrument regarding a particular price range.
The previous figure shows an example of the Fibonacci levels. We take any lower low and any other highger high and draw a line connecting both points. The fibonacci levels between those two points are usually a set of percentages of the total heigth between the two points. Other levels may be printed, but the most common ones are 0, 50, 61.8. It is not unusual finding this default setup:
Now, if you pay attention to the prior image, it happens that price usually bounces and ranges between those levels, therefore if we identify the level in which price is going to change its direction from, we can place an order exiting at the next Fibonacci level. In the last example, if we would have placed a buy order when the price crossed the 38.2 level the first time, we would have successfully sold with profit at the nearest Fibonacci level, 23.6.
I know traders who successfully use Fibonacci in their trades, if I am not using Fibonacci it is not to demerit the strategies that are profitable using it.
Why I do not use Fibos.
If I do not use Fibonacci is because to me, trading is:
- A matter of statistical price analysis.
- A matter of complete uncertainty about how price action will develop in the future.
- A matter of support and resistance game.
- Fibonacci establishes fixed levels not related to the actual price action.
- Fibonacci levels are not related to the actual price buildup.
- Fibonacci levels are a fixed structural deterministic approach and trading is dynamic and probabilistic.
- Fibonacci fails most of the time.
Now, look at the next image. The red circles mark the times in which Fibonacci trading failed. The problem is that you cannot predict when Fibonacci will work or how price will react at each level, just because Fibonacci levels are fixed no matter how price was moving before or how price is changing accross the different levels.
If you place buy in the red circles number 1, 2 or 5, the trade is lost. The same happens when placing sell when price is in circles 3 and 4. Therefore, Fibonacci levels cannot be traded in a direct way.
The first red circle failed because the 38.2 level had been already retested, the second red circle failed because buying after a bearish breakout is a very poor setup. The third red circle failed because the 61.8 level represents antoher poor setup: selling next to a strong support from a resistance that was just broken by a breakout candle and therefore it became a new support (and no one should sell on a support if we want to stay safe). To understand the third cicle, look at the initial green huge breakout candle on the left side of tha chart. That candle has just transformed every resistance in a potential support. Selling in potential supports is not a safe wager.
Using Price Action.
So, what is your solution for this?, you may ask.
As I mentioned, we can train our eyes and research how to identify the correct anchor points just by identifying them by analyzing the price history, chart patterns and price momentum. The exact same chart may be analyzed in a more realiable way by just understanding what each price move means.
So two immediate high probability trades can be depicted almost without too much effort within the same time range and without any indicator of course. I have drawn the dashed lines just by observing how the candles behave at the current scenario, without any predefined proportion nor shape.
One main rule here is: do not sell approaching near above a support and do not buy near below a resistance.
The conclusion about all this, for me, is that the Fibonacci levels are good to spot potential price anchor points, but they also put the trader in a worse danger: having the conviction that something that is not there exists and losing the edge on the market.
Why should I use predetermined not trustworthy levels when I can train my eyes to identify support and resistance levels looking at the naked price?
If I draw my lines by observing the actual price I do know that each of my lines is actually an anchor point. And I can also draw diagonal (not necessarily horizontal) and vertical lines to mark high probability trade areas. I can identifiy where the price structures lay on and represent indeed high support and resistance areas.
And I do not need Fibonacci to understand that I have to sell only when price is high and buy only when price is low. The fibonacci levels may convince me that the price is near to a strong level and cloud my mind with that conviction so that I do not see what is actually happening by looking at the main picture and the signs that contradict that conviction. One of the worst enemies of traders is conviction because our brains are designed to fight for our own convictions and deny what denies those.
Do you think a boxer can win a round if he always protects himself against the same fixed punch type just because he thinks it is the most probable among the rest?
For these reasons, I think that Fibonacci and any other indicators are usually very dangerous tools, especially for those who have not developed yet a working trading strategy without need of using them.